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Will the concept of goodwill go well with national accounting? Itsuo Sakuma (1) Abstract: The purpose of the present paper is to examine the concept of goodwill in the context of national accounting. Goodwill, originally a business accounting concept, was incorporated into the SNA in its 1993 version as a category of intangible non-produced assets, even though Japanese national accounts have never included it. The 2008 SNA introduced a composite category called goodwill and marketing assets and included it in the list of non-produced non-financial assets. By recognising that goodwill is just essentially net worth (as a national accounting concept) with the sign reversed, it may be very natural to ask whether it is necessary or not for national accounts. This paper gives a negative answer to the question and seeks to show that national accountants can fully and reasonably deal with business acquisitions without the concept. Some facts from business accounting history about the concept may bring insight into the problems involved. JEL codes: E01, M41, G34 Keywords: SNA, Goodwill, Net worth, Tobin’s Q (1) School of Economics, Senshu University. 3 Will the concept of goodwill go well with national accounting? 1.Introduction Goodwill is a business accounting concept that is used in national accounts, although this concept has never been included in Japanese national accounts. Business accountants would understand that the concept of goodwill is defined in national account‑ ing in the same way as in business accounting by reading the following citation from the SNA (2): ‘Potential purchasers of an enterprise are often prepared to pay a premium above the net value of its individually identified and valued assets and liabilities. This excess is described as “goodwill” …’ (2008 SNA, paragraph 10.196) In the 2008 SNA, a composite category called Goodwill and marketing assets is introduced, which includes marketing assets such as brand names, mastheads, trademarks, logos and so on, as well as goodwill. The description of this composite item is as follows: ‘The value of goodwill and marketing assets is defined as the difference between the value paid for an enterprise as a going concern and the sum of its assets less the sum of its liabilities, each item of which has been separately identified and valued. Although goodwill is likely to be present in most corporations, for reasons of reliability of measurement it is only recorded when its value is evidenced by a market transaction, usually the sale of the whole corporation. Exceptionally, identified marketing assets may be sold individually and separately from the whole corporation in which case their sale should also be recorded under this item.’ (2008 SNA, paragraph 10.199) Here, special attention should be paid to the mean‑ ing of the term ‘liabilities’. In the citations above, as business accountants understand the term, it is defined as excluding shares and other equity issued by the enterprise to be acquired. However, when national accountants define net worth as the value of all the assets owned by an institutional unit or sector, less the value of all its outstanding liabilities, (2) Three versions of the SNA will be referred to in this paper. They are United Nations (1968), Commission of the European Communities et al. (1993), and European Commission (2009), which are referred to as 1968 SNA, 1993 SNA and 2008 SNA, respectively. 52 they regard shares and other equity as liabilities (3). Thus the term ‘liabilities’ is given two different meanings in the 2008 SNA. In defining goodwill (and marketing assets) as described above, shares and other equity are excluded from the list of li‑ abilities (as in the business accounting definition of liabilities). However, when net worth is defined in the context of national accounting, shares and other equity are included in the list of liabilities (i.e. na‑ tional accounting concept of liabilities) (4). By comparing the two concepts, goodwill and net worth (in the context of national accounting) (5), you can find a close relationship between the two. That is, in the case of a corporation that has just been purchased and merged by another corpora‑ tion acquiring the whole equity (6). Net Worth (national accounting) = Assets – Liabil‑ ities (business accounting) – Equity (issued (7)), and Goodwill = Equity (issued) – [Assets – Liabilities (business accounting)], therefore, Goodwill = – Net Worth (national accounting). Then, a natural question may be whether the con‑ cept of goodwill is necessary or not in the SNA as it is just net worth with the sign reversed. The purpose of the present paper is to examine the concept of goodwill in some detail. The above ques‑ tion will be answered negatively. It will be shown that national accountants can deal with business (3) It may be easily understood by taking a glance at Table 13.1 in the 2008 SNA, for example. (4) Note that in United Nations (1977), the balance sheet version of the 1968 SNA, liabilities except shares and other equity are called ‘third-party liabilities’ while equity including shares is called ‘second-party liabilities’. (5) The term ‘net worth’ is used in business accounting as well, though in the context of business accounting, the list of liabilities excludes shares and other equity. The net worth formulated this way may be called the business accounting concept of net worth. (6) It is presupposed that the former corporation has not experienced any acquisition before so that goodwill does not appear in its balance sheet. (7) Shares and other equity owned are included in the list of assets in both accounting systems. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators Will the concept of goodwill go well with national accounting? acquisitions fairly reasonably without this concept. The present paper is organised as follows. The next section is devoted to business accounting history concerning the concept of goodwill, as some facts from history may provide insights into challenges we face. Four theories of, or views on, goodwill in business accounting context will be surveyed, on the basis of which, for example, it will be examined whether the introduction of the newly arrived cat‑ egory ‘goodwill and marketing assets’ may be con‑ sidered to be reasonable or not. In the third section, the treatment of goodwill in the SNA will be described more fully. In doing so, sev‑ eral important points will be made clear. It will be shown that ‘internally generated goodwill’, another business accounting concept, is not adopted in the SNA (as well as in any business accounting stan‑ dard) and that goodwill is recorded only when a business (or part of it, as in the case of Sony Corpo‑ ration’s selling its VAIO-PC business) is traded, so it is called ‘purchased goodwill’. In addition, we will go through topics such as amortisation/impairment 3 issues, problems related to the treatment of transfer costs involved with the business acquisition, etc. It should be noted that at this stage, the rationale for the concept of goodwill itself will not be challenged. In the fourth section, focus will be on the rationale of the business accounting concept of goodwill in the national accounting framework. As previously noted, it will be shown that a business acquisition may be fairly reasonably and more naturally de‑ scribed, by regarding it as the purchase of equity, rather than the acquisition of goodwill. It may be noted that a business or part of it to be acquired may be regarded as a quasi-corporation, if not a fully incorporated business. (Purchased) goodwill is, after all, just a token of the fact that the business experienced a business acquisition in the past. Fi‑ nally in this section, a very interesting relationship between the concept of net worth and Tobin’s Q, a macroeconomic concept, will be examined. Lastly, conclusions will be drawn and proposals will be put forth. 2.Four theories of goodwill: a historical perspective According to Yamauchi (2010), historically, there have been four views on ‘goodwill’ as a business ac‑ counting concept. They are: 1) intangibles theory of goodwill; 2) super-profit theory of goodwill; 3) residuals theory of goodwill; and 4) synergy theory of goodwill. They will be taken up in turn. For the sake of convenience, in what follows, historical cost valuations often found in business accounting will be totally ignored. Instead, the valuation at current prices including valuation at current replacement cost will be presupposed. 2.1. Intangibles theory of goodwill When an economic entity acquires a business (in‑ corporated or unincorporated), it may pay a sum of money that exceeds the amount of the tangible and identified intangible assets it owns net of related li‑ abilities, if any. This excess amount of money was, according to this theory, deemed to be the sum of the value of unidentified ‘intangibles’ including, among others, customer loyalty in the current busi‑ ness terminology. These types of payments were legally recognised and established by the late 19th century and called ‘goodwill’. A well-known remark ‘(the goodwill is) nothing more than the probabil‑ ity that old customer will resort to the old place’ was made by Lord Eldon in 1810 (8). More (1891) (p. 282) writes: ‘We all know — in a general way at least — what Goodwill is. It is, I take it, just another name to designate the patronage of the public.’ Thus, the continued patronage of customers includ‑ ing the factor of location was considered to be the essential elements of goodwill in the 19th century. However, by the early 20th century, various items such as good business management (if the old management is retained), excellent reputation, mo‑ (8) As cited in Yang (1927), p. 28. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators 53 3 Will the concept of goodwill go well with national accounting? nopolistic privileges, trademarks (if not separately traded), unidentified knowhow, and favourable at‑ titudes toward the firm on the part of employees, as well as bankers and investors (9), came to be recog‑ nised as intangibles involved in goodwill. That is, the value of goodwill G may be expressed as the sum of the values of unidentified intangibles I j ( j = 1, 2, , n); so that G = I1 + I 2 + + I n . It should be stressed that in the 19th century, enter‑ prises were seldom acquired by purchasing their shares in the organised stock exchange. So, it was necessary to evaluate the business itself without re‑ sorting to market evaluation. However, for valua‑ tion purposes, it may not be so helpful to assume that the value of goodwill must be the total value of intangibles involved. 2.2. Super-profits theory of goodwill Dealing with the question ‘How the goodwill at‑ taching to a business may be valued as between a willing seller and a willing buyer?’ (10), some ac‑ countants purported to find another seemingly bet‑ ter definition of goodwill by the early 20th century. Thus, among others, Greendlinger (1925) (p. 166) writes: ‘Good-will has been defined as that intangible quality of patronage which attaches to an established business and is presumed to continue, irrespective of any change of ownership. Perhaps, a better definition would be that good-will represents the present worth or capitalised value of the estimated future earnings of an established enterprise in excess of the normal results that it might be reasonably assumed would be realized by a similar undertaking established anew.’ The term ‘super-profits’ is due to Leake (1914) (p. 82). A pioneering contribution by More (1891) (9) Concerning the three categories of goodwill, consumer’s goodwill, industrial goodwill, and financial goodwill, see Yang (1927) (pp. 41–56) for example. (10)This question can be found in More (1891) (p. 284). 54 (p. 285) (11) gives a very simple numerical example: ‘A trading company with tangible assets, the full going value of which is ascertained to be £100,000, and suppose it is earning, and is likely to earn, eight per cent., or £8,000 a year. I would say that the total price should not exceed the value of the tangible assets, viz., £100,000, because no more than an ordinary return is being got. But suppose the concern is earning, and is likely to earn, thirteen per cent., or £13,000 a year, then I think a fair price might be seven annual payments of the extra £5,000, or a present payment of £26,030, being the amount of seven annual payments of £5,000, less eight percent discount. In this case, the price would be the above £100,000 plus £26,030, or together, £126,030.’ Why thirteen percent? The P&L statement of the firm may provide some information needed. Why seven years? While this may be a matter of nego‑ tiation between the buyer and the seller, it may be understood that it was taken for granted that good‑ will should be depreciated (or amortised). For the superior earning power was considered to decline over time, say, due to competition. Note that this definition is not contradictory to the older, intangibles theory of goodwill. In fact, Yang (1927), by maintaining basically the older theory, sought to show that the value of intangibles is essen‑ tially an expression of the superior earning power of the specific concern. However, it may be stressed that the two theories are logically independent, though some argue that goodwill in the super-profit theory is just a measurement concept. 2.3. Residuals theory of goodwill The residuals theory of goodwill appeared in the early 20th century and came to be established in the second half of the century. According to this theory, goodwill may be defined as the excess of the value of the business as a whole over the valuations at‑ (11)More’s paper was revised and published as More(1900–01) and the latter was reprinted and included in Lee (1984). According to the introductory note in the reprinted version(p. 65), ‘More’s contribution represents a scholarly paper, well ahead of its time — the usual practice for valuing goodwill being a multiple of total profits minus the valuation of tangible assets (a practice which More did not favour)’. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators Will the concept of goodwill go well with national accounting? taching to its individual tangible and intangible net assets (12). The residuals theory is considered to be originally due to Canning (1929) (pp. 42–43). He preferred to regard goodwill as ‘a master valuation account’. He wrote: ‘Goodwill, when it appears in the balance sheet at all, is but a master valuation account’. That is, goodwill is the balancing item for the subaccount, which appears in the balance sheet when a business combination occurs. So, naturally, goodwill becomes a ‘catch-all’ item. ����������� More impor‑ tantly, he also wrote: ‘It cannot under any circumstances be called an “asset”.’ This definition of goodwill is considered to be im‑ portant in that it is adopted by international and national business accounting standard setters in‑ cluding the Accounting Standards Board or ASB in the United Kingdom, among others. In fact, ASB (1997) (paragraph 2) defines (purchased) goodwill as ‘the difference between the cost of an acquired entity and the aggregate of the fair values (13) of the entity’s identifiable assets and liabilities’. At the same time, it may be noteworthy that this definition is quite generally accepted when the con‑ cept of goodwill was first introduced into the Sys‑ tem of National Accounts in its 1993 version. No less important is the fact that by the second half of the 20th century, the number of incorporated busi‑ nesses had increased drastically and acquiring busi‑ nesses by purchasing the outstanding shares on the stock exchange became more common practice. In fact, MacNeal (1939) (p. 233) wrote: ‘The total value of a business as a whole is best expressed by the price of its equities in the market place.’ However, as to the above three views on goodwill, Hendriksen (1977) (pp. 435–369) remarks as fol‑ lows: (12)This definition is found in Hendriksen (1977) (pp. 43–59). (13)According to the 1982 version of IAS 16(IASC (1982)), ‘fair value’ in the context of business accounting may be defined as the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction. 3 ‘The attempts […] to provide goodwill with semantic interpretation have basically failed. Furthermore, little or no evidence has been found to indicate that the reporting of goodwill provides relevant information for investors or creditors in their decision making. Because goodwill lacks real-world interpretation and cannot be measured independently, it should be omitted from financial statements. This does not mean, however, that aggregations of resources should not be reported separately from measurement of individual assets. Aggregations of resources may have valuations greater or less than the summation of identifiable parts because of synergism among the resources acquired or with resources already owned.’ 2.4. Synergy theory of goodwill According to the Oxford Dictionary of English, ‘syn‑ ergy’ means the interaction or cooperation of two or more organisations, substances, or other agents to produce a combined effect greater than the sum of their separate effects. By noticing that (purchased) goodwill is recorded when an event of merger and acquisition occurs, it is not difficult to find that there may be some syn‑ ergistic effects involved. As Hendriksen suggested, there may also be synergistic effects among a num‑ ber of asset items in the balance sheet of the ac‑ quired enterprise as well as the acquiring firm. Be‑ cause of this, as Schmalenbach (14) correctly argued at latest as early as 1910s, if resources are tied up in a business, they do not possess individual values. Instead, a collection of resources has only a collec‑ tive value. The following somewhat long citation is from Schmalenbach (1959) (p. 26). ‘If a landlord owns ten houses, he can list their values on the assets side of his balance sheet, the liabilities, including mortgages, on the liabilities side, and the result is a balance sheet which shows the value of his capital. The accuracy of this value depends upon accuracy of the individual valua(14)Eugen Schmalenbach (1873–1955) is a versatile German academic whose fields include economics, sociology as well as business accounting. Schmalenbach (1959) is an English translation of his famous book Dynamische Bilanz (Dynamic Accounting), which first appeared in 1919 and went through several impressions. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators 55 3 Will the concept of goodwill go well with national accounting? tions. This apart, there is nothing wrong with the procedure. However, if a man owns a business which is made up of buildings, machines, tools, office equipment, stocks, debtors, creditors and more, he cannot arrive at a true value for his capital by means of the above accounting procedure, no matter how the individual values are arrived at; for the value of a business does not equal the total of the values of its individual parts. The value of business depends upon its suitability for the manufacture or sale of useful things. If a collection of buildings, machines and stocks are needed for this, then there is a collective value. As long as they are tied up in the business, they do not possess individual values. The machines had individual values once, before they were installed, when they were still in the hands of a dealer. They can have individual values again, if they are dismantled and sold as used machines. But as long as they are tied up in the factory there can be no talk about individual values.’ The synergy theory of goodwill emerged as the newest theory of goodwill in the late 20th century. Thus, Miller (1973) (p. 281) wrote: ‘The essential characteristics of a system is a collection of functioning elements, such as the parts of an automobile engine, that work together as a unified whole because of relationships among the elements of the system. […] Systems may be most complex. Some are almost incomprehensible as aggregates of elements because interaction of the parts results in synergy.’ In recent decades, this new theory made a big step toward winning general acceptance in wider ac‑ counting circles. Many authors, including Ma and Hopkins (1988), Johnson and Petrone (1998), and Yamauchi (2010) among others, have contributed to the development of the theory. At present, no one can deny that the measure of goodwill includes synergies in its core component. In fact, Johnson and Petrone (1998) (pp. 295–296) propose that the term ‘core goodwill’ exclude intangible elements as well as overpayment (or underpayment) due to any valuation error or fire sale (and so on), but just in‑ 56 cludes ‘going concern goodwill’ and ‘combination goodwill’. The former refers to the synergies which may be generated from tying up the assets in the balance sheet of the acquired enterprise and the lat‑ ter refers to the synergies from combining the two businesses. Yamauchi (2010) (pp. 146–157) clarifies that the measure of goodwill actually brought into the ac‑ counts may include the values of unidentifiable intangibles that are not deemed to be assets in the business accounting standard (human capital, for example), as well as the values of unrecognised intangible assets (certain R&D assets that were re‑ corded as costs incurred as corresponding R&D expenditures were made). Thus, by excluding these values, the purification of the concept of goodwill is possible, at least theoretically. This may be the right place to consider the newly coined composite item ‘goodwill and marketing as‑ sets’. Here, a full description of the term ‘marketing assets’ is given in paragraph 10.198: ‘Marketing assets consist of items such as brand names, mastheads, trademarks, logos and domain names. A brand can be interpreted as far more than just a corporate name or logo. It is the overall impression a customer or potential customer gains from their experience with the company and its products. Interpreted in that wider sense it can also be seen to encompass some of the characteristics of goodwill, such as customer loyalty.’ From the historical point of view, we understand that the author is dubious about this treatment, even on the presumption that we would accept the concept of goodwill. For synergies involved in the measure of goodwill and marketing assets such as logos, etc. are so different to be wrapped up in an item. Understanding goodwill as a synergy is not con‑ tradictory with the residuals view on goodwill, as the latter could be seen as a measurement concept. However, as noted earlier, the central claim in Can‑ ning (1929) is that goodwill is not an asset, which does not seem to be shared with advocates of syn‑ ergism. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators Will the concept of goodwill go well with national accounting? 3 3.Treatment of goodwill in the SNA revisited 3.1. The introduction of the concept of goodwill in the SNA and challenges confronted As noted earlier, the 1968 version of the SNA (the 1968 SNA as well as United Nations (1977) as the balance sheet version of the 1968 SNA) lacks the concept of goodwill (15). It was the 1993 version that introduced the concept for the first time, though it is somewhat different from that in the 2008 SNA. What follows is from paragraph 12.22 in the 1993 SNA: ‘When an enterprise is sold at a price that exceeds its net worth, this excess in purchase price over net worth is the asset, “purchased goodwill”.’ However, this definition cannot be applied to the purchase/sale of a corporation if the definitions of liabilities and net worth are to be retained through the system. In fact, in the 1993 SNA, purchased goodwill was necessarily calculated differently de‑ pending on whether the business to be acquired was an unincorporated enterprise or a corporation. The following is also from the same paragraph: ‘Two cases must be distinguished. For the sale/purchase of an unincorporated enterprise not treated as a quasi-corporation, the purchased goodwill represents the excess of the purchase price of this enterprise over its net worth (derived from its separately identified and valued assets and liabilities) […] For the sale/purchase of a corporation or quasi-corporation, the purchased goodwill represents the excess of the purchase price of its shares and other equity over their value just prior to the sale/purchase.’ Accounting procedures for the purchase/sale of in‑ corporated businesses were described in the same paragraph as follows: (15)Although no mention was made of goodwill in the 1968 SNA or United Nations (1977), it might be quite likely that national accountants had no choice but to use business accounting records to estimate the figures for intangible assets except claims (non-financial intangible assets) so that goodwill could be mingled with intangible assets like patents and copy rights. ‘This excess enters the balance sheet of the seller of shares and other equity prior to the sale as a revaluation of a financial asset so that the shares and other equity can be sold at their purchase price. At the same time, the purchased goodwill enters the other changes in the volume of assets account as an economic appearance of an intangible non-produced asset and is recorded as such in the closing balance sheet of this corporation or quasicorporation. The sales and purchases of the shares and other equity are recorded in the financial accounts of the seller and the purchaser.’ Thus, in the 1993 SNA, goodwill for the purchase/ sale of incorporated businesses was defined dif‑ ferently from the concept in the original business accounting context. This definition of goodwill (specifically for the purchase/sale of incorporated businesses) may sound ridiculous to business ac‑ countants. In fact, they have never encountered a treatment of goodwill like that in the 1993 SNA. Thus, the 1993 SNA failed to introduce the concept of goodwill in a way that would satisfy business ac‑ countants, although it seems that it did try not to disturb the conceptual framework of the SNA. In passing, it introduced a new category called ‘intan‑ gible non-produced assets’, inclusive of goodwill, replacing the older term ‘non-financial intangible assets’. The 2008 SNA took a different approach. That is, it tried to incorporate goodwill just as business ac‑ countants understand the term. However, as a mat‑ ter of course, the strategy resulted in inconsistencies brought into the system, as was noted earlier. Thus, there were challenges to be met. That is, in order to include goodwill in the list of intangible assets of the conceptual system of the SNA, national ac‑ countants need to modify the business accounting concept of goodwill or to tolerate inconsistencies brought in. Incidentally, a new category ‘non-pro‑ duced non-financial assets’ was created in the 2008 SNA, making the tangible-intangible distinction a fringe one. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators 57 3 Will the concept of goodwill go well with national accounting? In what follows in this section, some additional de‑ scriptions of goodwill in the SNA will be given and examined. 3.2. The exclusion of internally generated goodwill With regard to the definition of goodwill in the 2008 SNA cited earlier in the present paper, it may be noted that goodwill is recorded only when a business (or part of it) is actually traded. This type of goodwill is called ‘purchased goodwill’ (16). It is the case with the 1993 SNA version of the concept as well. In fact, according to paragraph 12.22, ‘Goodwill that is not evidenced by a sale/purchase is not considered an economic asset: the only way that goodwill enters the System is for such a purchase to occur (17).’ However, goodwill, which is defined as the excess of the sale/purchase price of the business over its net worth (business accounting concept), may be con‑ ceivable even when an actual sale/purchase does not occur, by estimating the sale/purchase value of the enterprise. It may particularly be the case when the incorporated enterprise is listed and its shares are traded in the stock exchange. Goodwill in this case may be called ‘internally generated goodwill’. Business accounting standards uniformly rule out the concept. In fact, for example, Ma and Hopkins (1988) (p. 84) described the concept as an ‘Alice-inWonderland’ type of accounting concept. The SNA, in its 2008 version, excludes the concept as well. The third chapter of Bloom (2008) gives an excel‑ lent account of how the goodwill write-up was tem‑ porarily condoned and brought an anomaly into the accounts in the early 20th century before the De‑ pression era and how non-recognition of internally generated goodwill was established in the United States after the period. (16)The term ‘purchased goodwill’ may be used in another context in which the amount does not include the minority owners’ equity. The 2008 SNA is not so clear about how you can deal with it. (17)The first half of this sentence may be found in paragraph 12.26 in the 2008 SNA as well. 58 3.3. Negative goodwill According to the definition of goodwill in the 2008 SNA, it may be understood that goodwill may well be negative. In fact, the 2008 SNA specifically ac‑ cepts that the measure of goodwill can be negative. What follows is from paragraph 12.33: ‘The value (of goodwill) may be positive or negative (or zero). By its calculation and designation as an asset of the enterprise, the net worth of the enterprise at the moment it is bought is exactly zero, whatever the legal status of the enterprise.’ The treatment of negative goodwill in business ac‑ counting standards varies. Regarding it as a profit on acquisitions, seems to be a typical response to the situation by business accountants. From what is cited, again, it may be known that goodwill + net worth (in the sense of national accounting) = zero. 3.4. Appearance of goodwill in the accounts and amortisation/ impairment According to paragraph 12.34 in the 2008 SNA, the recording of the appearance of goodwill (and mar‑ keting assets) will be made as follows: ‘The value of purchased goodwill and marketing assets is calculated at the time of the sale, entered in the books of the seller in the other changes in the volume of assets account and then exchanged as a transaction with the purchaser in the capital account.’ The entries are as follows. Goodwill and market‑ ing assets first appear in the balance sheet of the seller via the other changes in the volume of as‑ sets account. The entry is an economic appearance of a non-produced non-financial asset. Then the disposals (acquisitions) of the item are recorded in the capital account of the seller (the purchaser) as ‘disposals (acquisitions) of non-produced nonfinancial assets’. And then, goodwill and marketing assets are recorded in the closing balance sheet of the purchaser. The next step is to record the amortisation of the asset in question. What follows is from the same paragraph: EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators Will the concept of goodwill go well with national accounting? ‘Thereafter the value of the purchased goodwill and marketing asset must be written down in the books of the purchaser via entries in the other changes in the volume of assets account. The rate at which it is written down should be in accordance with commercial accounting standards. These are typically conservative in the amount that may appear on the balance sheet of an enterprise and should be subject to an “impairment test” whereby an accountant can satisfy himself that the remaining value is likely to be realizable in case of a further sale of the enterprise.’ Business accounting rules concerning amortisation (and impairment tests) vary over time, as well as from country to country. Thus, while the IFRS (In‑ ternational Financial Reporting Standard) prohib‑ its amortisation and requires the implementation of an impairment test at least once a year, a regular amortisation of goodwill over its economic life (20 years at longest) is mandatory under Japanese busi‑ ness accounting standards. However, to enhance international comparability of business account‑ ing records, voluntary application of the IFRS rules started from the consolidated fiscal years ending on or after March 31, 2010 in Japan. It may be worth mentioning that business circles in Japan claimed that the application of the IFRS rules to financial reporting would encourage M&A activities by Japa‑ nese companies. Nevertheless, some business accounting specialists in Japan now argue that the application of the IFRS rules will make some accounting figures, including profits in addition to goodwill itself, rather unstable over time. Thus, if national accountants have no choice but to rely on business accounting records to estimate goodwill figures in national accounts, it should be understood that the figures will be highly 3 volatile and country-to-country comparability may be quite doubtful. In any case, the 2008 SNA stipulates the use of an amortisation rule together with an impairment test approach. While the scope of asset items over which the impairment test should be applied is not clear in the above paragraph, a possible criticism against the treatment may be that some elements of internally generated goodwill could be mixed up in the mea‑ sure because the futuresale value may include them. 3.5. Costs of ownership transfer This point is related to costs associated with the acquisition (disposal) of goodwill. Of course, in the SNA, goodwill is one of the categories of nonfinancial non-produced assets, so that the costs of ownership transfer incurred with regard to the acquisition (disposal) of goodwill are treated as fixed capital formation. However, the acquisition (disposal) of goodwill can be done only through the acquisition (disposal) of a business, while the purchase of the business can be done by acquiring the controlling equity in it. Because equity is in the list of liabilities in the SNA, the costs of ownership transfer involved with the acquisition (disposal) of equity are treated as inter‑ mediate consumption. For example, research costs (including fees paid to financial advisers) about the enterprise to be acquired may be incurred by the acquirer. Are they intermediate or final? Japanese business accounting standards recently changed their position concerning the treatment of financial adviser’s fees. Previously, they were con‑ sidered part of goodwill, but now they are regarded as current outgoings. 4.How you can do without the concept of goodwill 4.1. How to record business acquisitions incorporated entity. Regardless of whether the business is incorporated or not, the fact that it is sold, tells us that it can be deemed to be at least a quasi-corporate if not a fully However, in practice, it is perfectly possible that the business (to be sold) is just part of a household, previously. In such cases, it is necessary for the busi‑ EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators 59 3 Will the concept of goodwill go well with national accounting? ness in question to be reclassified to the corporate sector (from the household sector) prior to the sale/ purchase. It is assumed that the household sector now has equity in the quasi-corporate. The equity in question must be introduced into the system via the other changes in the volume of assets account, as an economic appearance of financial assets/liabilities (assets of the household, liabilities of the quasi-cor‑ porate). Then, when a business acquisition occurs, the sale/purchase of the equity of the business is re‑ corded. The value of the equity in question depends on the purchase price of the business that was for‑ merly part of a household. After the acquisition, the business is merged into the acquiring corporation; therefore the equity will disappear because the issuer of the particular li‑ abilities is merged with the holder of it. The share price of the acquiring entity and hence net worth (national accounting concept) of the corporation may increase or decrease depending on the market evaluation of the acquisition. It seems that there is no room for the entry of goodwill. 4.2. T-form presentations relating to purchased goodwill, internally generated goodwill and net worth Table 1a shows the balance sheet of the business to be acquired by using national accounting concepts. Suppose that the business to be acquired has not ex‑ perienced any acquisition before, and the purchase price of the business is the transaction value of its shares outstanding. In the table, this value is shown as equity (18). The same situation is shown differ‑ ently in Table 1b. Table 1a: The balance sheet of the business to be acquired (by using national accounting concepts only) Assets Liabilities other than equity Equity Net worth Note: The business to be acquired has never experienced acquisition so that assets on the left-hand side do not include goodwill. Table 1b: An alternative presentation of the balance sheet of the business to be acquired (with net worth as a business accounting concept) (–) Net worth = Goodwill (to be re‑ corded in the acquirer’s accounts) Equity (–) Net worth (*) Note: Purchased goodwill to be recorded in the account of acquiring business equals to (–) Net worth (national accounting concept) of the business to be acquired. 60 Let us suppose that an enterprise experienced ac‑ quisition once in the past. Goodwill was recorded then and has been written down at a certain previ‑ ously-determined rate until now. the tangible-intangible distinction that you may find appearing on the debit side of the accounts (19) almost ceased to exist in the 2008 SNA. In Table 2b, net worth is defined in the fashion of business ac- Tables 2a-d show the balance sheet of the enterprise in four different ways. Table 2a is a national ac‑ counting presentation of the situation, even though (18)In the T-forms in this section, asterisk (*) denotes that the item is a business accounting concept. (19)Computer software should be deemed to be tangible except for certain development costs. See Sakuma (2013) (pp. 564–65). EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators Will the concept of goodwill go well with national accounting? counting. In Table 2c, the situation involves the write-up of internally generated goodwill. In 3 Table 2d, the same situation as Table 2c is presented in a somewhat different way. Table 2a: The balance sheet of the acquiring business some years later (by using national accounting concepts only) Tangible assets Intangible assets other than goodwill Purchased goodwill Liabilities other than equity Equity Net worth Note: A close relationship between purchased goodwill and net worth that existed at the time of the acquisition is not retained because of amortisation. Table 2b: The balance sheet of the acquiring business some years later (by using a business accounting concept of net worth) Tangible assets Intangible assets other than goodwill Purchased goodwill Liabilities other than equity Net worth (*) Note: The lack of equity data in the account makes business accounts less informative. Table 2c: The situation involving the write-up of internally generated goodwill Tangible assets Intangible assets other than goodwill Purchased goodwill Liabilities other than equity Net worth (*) Internally generated goodwill Note: The write-up of internally generated goodwill may make the business accounting concept of net worth less useful. Table 2d: A presentation using national accounting concept of net worth Tangible assets Intangible assets other than goodwill (–) Net worth (Purchased goodwill) (Internally generated goodwill) Liabilities other than equity Equity Note: Net worth that appears with the reversed sign on the left-hand side of the account is defined in a national accounting fashion, but the list of assets excludes purchased goodwill as well as internally generated goodwill. This form of presentation is somewhat similar to 'market capitalisation statement' in Bloom (2008). EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators 61 3 Will the concept of goodwill go well with national accounting? From the presentations above, it may be concluded that it is quite difficult to measure purchased good‑ will over time separately from internally gener‑ ated goodwill. A particular business acquisition brings about a particular synergy which is subject to change over time. This cannot be estimated in‑ dependently from synergy newly created after the acquisition. Thus, goodwill evidenced by a business combination will be inevitably mixed up with inter‑ nally generated goodwill. It is net worth, (as a na‑ tional accounting concept) not purchased goodwill, that is meaningful. As already shown, business acquisition may be ac‑ counted for more naturally by regarding business acquisition as the purchase of equity rather than the acquisition of goodwill. An interpretation may be that purchased goodwill is, after all, just a token that shows the entity experienced a business acquisition in the past. In addition to inconsistencies brought into the sys‑ tem as already mentioned, by considering practical difficulties about using business accounting data to estimate comparable figures for goodwill (and mar‑ keting assets), this author would like to propose to end the use of the concept. 4.3. Tobin‘s Q from the viewpoint of synergy James Tobin, Nobel laureate in Economics, devised a ratio called Tobin’s Q, which may be defined as: the market value of the firm the replacement value of the firm ' s assets Here, the market value of the firm means the to‑ tal market value of its shares and other equity and the firm’s assets should be understood to be its net worth as a business accounting concept. The origi‑ nal formulation of Tobin’s Q may be found in Tobin (1969). Although a prevalent adjustment-cost type of interpretations of the Q theory may be found in Yoshikawa (1980) and Hayashi (1982) among oth‑ ers, his own account of Tobin’s Q may be found in an interview with The Region, a periodical issued by the Federal Reserve Bank of Minneapolis (20): (20)Tobin (1996). 62 ‘The idea is to think about the productive, physical assets of a company — maybe people think of it as book value of a company — but convert that into the replacement cost of the assets, not the original cost. How much would it cost to buy the assets again, new, off the production line? So, that’s one valuation of the firm. Looking at it that way, then, there’s the market valuation, and one way of having a market valuation would be to have used capital goods markets — used car markets or used house markets. But for many things that’s not a practical matter, so we have a used business market implicit in securities markets, stock and bond markets. And that’s the ratio. The replacement costs are the denominator, the securities market valuations are the numerator. Now, you might think that the value of this should be 1, that arbitrage would keep the two valuations the same. If people have a choice, they either buy new, build a new plant or buy another firm that already has a plant, in the securities market. That’s arbitrage. Now, of course, there are going to be deviations from 1, obviously, even if the measurements were precise, which they’re not — there would be deviations from 1 because of goodwill or monopoly value or things like that. But at any rate, it is possible to estimate this number on an aggregated basis as well as on a disaggregated basis.’ Tobin’s Q, as a theory of the investment behaviour of a firm, may be most easily understandable by reading the paragraphs cited from Schmalenbach (1959) again. According to this citation, tying up the assets makes synergism. If a positive synergy is generated, investment in these assets may bring gains to investors. Thus, the fact that Tobin’s Q >1 may be regarded as a stimulus to investment (21). In fact, by deleting goodwill from the asset list if necessary, Tobin ' s Q = Equity > 1 or < 1 Assets − Liabilities other than equity is equivalent to (−) Net worth > 0 or < 0. (21)About the Q-theory of mergers, see Jovanovic and Rousseau(2002), for example. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators Will the concept of goodwill go well with national accounting? Noteworthy may be the fact that Tobin suggested goodwill and intangibles may be regarded as dis‑ turbing factors to the functioning mechanism of Tobin’s Q. In fact, in following the cited paragraphs above, he wrote: 3 be very informative for telling you about Microsoft. If more of the economy is like that, it’s going to be different from what it used to be.’ Because intangibles including intangible assets (hu‑ man capital, copyrights and so on) and tangible assets (machines, farm land, factories, computer software) have different positions in the produc‑ tion process of the firm that ties up these assets, they should be differently treated in the calculation of Tobin’s Q. For example, deducting the value of intangibles as well as goodwill from the numerator and denominator may be one possibility. That is, modified Tobin’s Q may be defined as follows: ‘Now, it is true that there may be a change in the ratio between goodwill, human capital, things that are not in the commodity market, that are the basis for the valuation of firms — like Microsoft. Microsoft is not being valued at what it is now because of bricks and mortar and even chips-microprocessors. It is being valued as it is now because it has a kind of monopoly lead based on its ability to keep innovating and to have its hands on human capital of a superior kind Equity − the value of intangibles — an organization of a superior kind. So, if that’s the Modified Tobin ' s Q = Assets less intangibles − Liabilities other than equity Equity − the value of intangibles case, then the ‘q’ ratio, which requires a replacement Modified Tobin ' s Q = Assets less intangibles − Liabilities other than equity cost calculation in the denominator, is not going to 5.Conclusions and proposals Conclusions are as follows: (1) While there have been different views on goodwill, the synergy viewpoint may be most persuasive. (2) The concept of goodwill is not necessary for national accountants and goodwill should be excluded from the list of assets. (3) Business acquisition can be dealt with and ana‑ lysed not by using the concept of goodwill, but by using equity (market capitalisation) and net worth as a national accounting concept. In addition, the present paper showed: (5) There is a very interesting relationship between net worth as a national accounting concept and Tobin’s Q. EURONA — Eurostat Review on National Accounts and Macroeconomic Indicators 63 3 Will the concept of goodwill go well with national accounting? Acknowledgements This paper was originally prepared for the 33rd General Conference of the International Association for Research in Income and Wealth, Rotterdam, the Netherlands, August 24–30, 2014. Among his many debts, the author is grateful to Erich Oltmanns, who discussed the paper at the conference, as well as Peter van de Ven, André Vanoli, and Albert Braakmann, who gave valuable comments. 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